Archive for the ‘Banking and Finance’ Category

Greek forecast fail

Here’s one simple graph that reveals an awful lot about the mess in Greece.  It shows how Greek GDP has changed over the last few years and how well the experts of the European Commission, the European Central Bank and the International Monetary Fund (collectively the ‘Troika’) have forecast it since the start of the crisis.

It’s not too easy to read but the black line is the actual change in Greek GDP (expressed as the percentage change on the previous year) and goes from a little over 3.5% in 2007 to around -7% in 2011.  The dotted red lines are successive annual forecasts from 2008 to 2012  (H/T Zero Hedge/Follow the Money).

Obviously, the Troika is totally and consistently incompetent at forecasting.  To be so reliably bad it must be sticking to a wholly wrong theory of how an economy works.  It’ as bad a series of misses as you would expect if NASA was trying to send a probe to Mars while remaining unshakably convinced of the Ptolemaic theory that the Sun and other planets go round the Earth.

The only other reason I can think of is that these were never intended to be serious forecasts at all; that they were just a way of dressing up a real strategy that dare not speak its name – for instance that it was a way for those calling the shots (i.e. largely France and Germany) to save their banks from bankruptcy by buying time for them to get their money out of Greece and dump the losses onto unsuspecting Eurozone taxpayers.

The two explanations are not mutually exclusive so could both be true.  That would be my bet but either way how much longer can it go on?  The new Chinese leadership is apparently reading de Toqueville on the causes of the French Revolution.  EU leaders should join them.


From Beveridge to Dickens

High on the wish list of the US GOP’s right-wing is the abolition of welfare.  Today some of that argument spilled over to this side of the Atlantic when the Radio 4’s World at One staged a brief debate between Tom Palmer, who is over here to promote his new book ‘After the Welfare State’, and Graeme Cooke of the IPPR.

The right’s argument is based on a steaming pile of falsehoods but well honed in the US for maximum impact.  It should be squashed before it gets established over here.

The central argument is that welfare is a monstrously unsustainable pay-as-you-go (unfunded) system that has accumulated staggering financial liabilities, not just in Britain or the US but generally in the developed economies.  Palmer asserts that in the UK the unfunded liability over a 50 year horizon is an astonishing 500% of GDP, that it’s a fundamentally bankrupt ‘pyramid scheme’ and that if this was done by a company its finance director would be indicted for fraud.

Wow!  Scary stuff.  As of course it’s meant to be.  Part of the plan is to so stun listeners that they react emotionally, not on the basis of rational analysis.

Start with that 500% of GDP deficit; this is the (small) difference between two very large numbers – the income and expenditure of the welfare system – extended over 50 years.  If either very large number is only very slightly out that makes a big difference, a huge difference over 50 years.  So does Palmer really think he knows the future, is he saying that he can forecast these two big numbers very accurately for two generations ahead?  I don’t think he can!  And the corollary is that a small tweak to either income or expenditure or both makes a dramatic change to the claimed deficit.   That is why the government keeps retirement age, contribution rates and inflation adjustments under review and sometimes changes them, for instance in response to increasing life expectancy.  What may look like small changes actually make a big difference.

Then there is the faux alarm about the deficit being ‘unfunded’.  Think about this for a minute.  One way or another the current working-age population has to look after those who are too old or too young or too ill to work so whether this support is funded or not changes the accounting entries but not the underlying reality.

If funded, people save during the years they are working putting their savings into the stock market or a house that they can downsize on retirement.  The next generation’s support is transmitted to them either when they sell their house to a young couple or by the dividends arising from the younger generation’s work.   If unfunded, money simply flows directly from the working cohort to the retired via a government administered bureaucracy.   In practice we use a combined approach in Britain; the state uses an unfunded system to provide a basic but (hopefully) decent safety net, the more prudent add to this through their own efforts – or sometimes by being lucky with their employer!

As for the argument that it would be fraudulent for a company director to run a pension scheme like this, that too is complete nonsense – companies and governments are completely different beasts.  Trying to pretend that apples are oranges is disingenuous in the extreme.

There is a problem with welfare but Palmer didn’t comment on it, possibly because his preferred approach doesn’t help.   The next generation will have to pay so much of their income for housing as a result of the increase in its real price in recent years that there will be little spare income to devote to welfare.  Wealth that should have gone one way or another to support the old, the young and the sick has instead been diverted to enrich the current generation of financiers.   All those bonuses had to come from somewhere.

The real motive behind this right-wing fantasy is, of course, to see welfare privatised which would be a huge windfall for the financial sector.  In place of a public service we would have competition.  Anyone who believes this would be great for pensioners probably also believes in the unicorns and the tooth fairy.

Palmer apparently believes that private welfare worked perfectly well before there was a state system.  As it happens there is a word for that – ‘Dickensian’.

Selling the family silver – let’s have reciprocity

China’s sovereign wealth fund has bought a stake of nearly 9% in Thames Water and Chancellor George Osborne is pleased about it, boasting that, ” It is a vote of confidence in Britain as a place to invest and do business.”   I would describe it more as selling the family silver.

Infrastructure companies are made to measure for ‘widows and orphans’; they offer investors relatively stable income streams over many years and are very unlikely to be wiped out by technological change as Kodak was earlier this week.   All of which makes them ideal investments for pension funds which must fund their long-term liabilities to pensioners with suitable investments.   With interest rates at record lows the relatively stable income from infrastructure companies is more than ever needed to pay pensions.  Something is very wrong if we have to go half way round the world to find investors; I thought the City was supposed to be the world capital of, err, capital!

In a well run world people in their peak earning years would build up a pot of savings, either as individuals or through a company pension scheme.  Then, after their retirement, they would draw down their savings leaving the next generation in turn as the capital providers for industry giving them in turn a pension to look forward to.

But this deal breaks the circle.  The next generation will now have to work twice as hard – first to earn their way in the world and second to pay the dividends that are going offshore.   This doesn’t work unless we see a step change in the size and competitiveness of British industry that was last world-beating (with honourable exceptions) in about 1850.  Unfortunately, there is no sign of that changing anytime soon.

For this and other reasons most countries would not sell their basic infrastructure off.  We do because, in the infinite wisdom of the market fundamentalists, there should be no borders to the free flow of capital.  That’s an argument for another day; suffice to say for now that, even if the fundamentalists are 100% correct, most others are not playing by the same rules nor is there any incentive for them to do so.   Can you imagine, say, Centrica (the company behind British Gas) being allowed to become the dominant gas supplier in France in the way EdF has been allowed to move into electricity in Britain?   At the very least we should insist on reciprocity; companies from another country operating in sector X should be free to invest here only if UK firms operating in sector X could do the opposite deal and acquire comparable assets in that country.  That simple rule would go a long way to levelling the playing field and no-one could argue that it wasn’t entirely fair.


Crime decriminalised

What have the Occupy protesters got to complain about?  Why don’t they just go home and leave things to the properly elected politicians?

Well, it turns out that they have a point.  As a new report shows, despite an epidemic of financial crime federal prosecutions in the US have fallen to under half their level of a decade ago.   The downward trend became firmly established in the presidency of G W Bush and has continued under Obama. The chart shows federal prosecutions each year for the last two decades and four presidents.

The FBI warned as long ago as 2002 that an epidemic of financial fraud was building yet nothing was done in the face of willful blindness on the part of bank executives, regulators and politicians.    Policing and regulation (which in this context are much the same thing) completely failed leading to the wave of subprime fraud which eventually broke in 2007 precipitating the world into Depression.

But the subprime meltdown would not have been nearly as serious as it was unless the system was already in a fragile state because so many banks and other institutions had long been exploiting the near absence of any regulation to make hay in ways that history shows inevitably lead to a meltdown.  So subprime was only the trigger.  Dozy regulators are one thing; remaining fast asleep after 2007 is quite another yet, as the chart shows, that’s exactly what has happened; prosecutions have fallen because, whatever the law say (and it says plenty) there had been a de facto decision to decriminalise … well, crime.

Obama came to power amid much hope that he would take control and sort things out.  But nothing; he reappointed Bush’s economic team and did nothing to prosecute offenders despite abundant evidence.  Which is to say that he, and his appointees like Attorney General Eric Holder have made being blind a matter of deliberate policy.   Obama might have chosen to clean out the frauds saying of the inevitable reaction, “I welcome their hatred” as FDR, who understood the score, said when faced with epidemic levels of fraud in the Great Depression.  Instead he chose to try to reconstruct the economy with the criminals in place – a policy that has failed.

Not surprisingly the country is seething and Occupy is the response.

Fortunately the situation is nowhere near as bad in the UK  but there is no room for complacency either.  Almost all the bailout has gone to the bankers and very little to the real economy – a point which last night’s Question Time audience clearly understood.  With the bankers likely to need another bailout very soon, the politics of this are going to get interesting; any party on the wrong side of events is going to be history.

Why RBS and other banks pay big bonuses

RBS yesterday reported that 323 of its staff are to share a bonus pot of £375 million which in another universe would be enough to employ 12,500 teachers at £30k each.  And yet it turns out that this is just the tip of the iceberg.  According to the BBC this is just the figure for its “code” staff as defined by the FSA – that is those executives who are perceived to do things that have a bearing on the risk the bank takes, but excluding other staff such as traders who earned even more than this.

There is obviously something very wrong here and the public is predictably outraged but powerless.  The banks will claim that they have no choice if they are to remain competitive and the politicians will make ritual comments deploring greed, but actually do nothing, not even where the state has the majority shareholding.

Yet, why banks pay these obscene sums is a question I have yet to see the mainstream press even ask, let alone answer.  In fact, the only place I have found a coherent account of this by a banking insider is in Yves Smith’s “Econned: How unenlightened self-interest undermined democracy and corrupted democracy“.   She also writes the excellent (and deeply liberal) naked capitalism blog – see links.

So, with apologies if I’ve got anything materially wrong, here is what I understand from her work plus bits and pieces from other sources.

The big investment banks are financial services conglomerates bringing together under one corporate roof many very different businesses.  Many of these businesses operate in markets that are not very liquid (which means that margins tend to be high) and/or which are very complex (also meaning that margins tend to be high).   The newer, the more complex and the harder-to-understand  a bank’s products the better the chance it has to make exceptional profits by, not to put it too finely, exploiting its better knowledge and market power to fool and gouge its customers.  Simple and transparent are NOT virtues in the world of investment banking.

Naturally, sailing close to the wind like this soon brings traders up against the limits of law or regulation.  But not usually for long; laws and regulations can often be circumvented by a subtle change of wording; for example Credit Default Swops are a form of insurance but, by calling them “swops” they evade regulations that would apply to insurance (obviously this needs a supine regulator as well so wording changes per se are only part of the story).  If clever rewording doesn’t work, there is still the option of “regulatory arbitrage”.   If a particular scheme is illegal in, say, London then the business can be done in the name of a subsidiary in Dublin or the Caymans or some other jurisdiction that specialises in facilitating dodgy dealing (as does the City in some instances).   All it requires is an “innovative” approach that finds ways round difficulties.

That is why banks place great emphasis on “innovation” and often stress how important, fundamental even, it is to their business.  But this sort of innovation is socially toxic, an evil twin of innovation in more life-enhancing fields.  No less an authority than Paul Volcker, a former chairman of the Federal Reserve has opined that the peak of useful innovation in banking was the invention of the ATM and that, “he has yet to see any evidence that financial market innovations have provided any benefit to the economy.

When huge short-term profits are the reward for evading regulation, then the inevitable outcome is a race to the bottom as banks strive to outdo each other, leaving no stone unturned in the search for short-run profit, no matter how risky or destructive their activities are in the medium to long run.  The justification is always “efficiency” which, in finance, means higher profit (or putatively for bank customers, lower costs).   But “efficiency” is always a trade-off with “stability” in a complex system.  The profits may indeed be lower for a time – until the whole systems blows up.  Funnily enough this trade-off is never pointed out – but then stability doesn’t pay bonuses.

Another feature of investment banking is that profit opportunities are typically fleeting, depending on an ever-changing transaction flow so, to be competitive, a firm must delegate a great deal of authority to relatively junior traders and analysts who have world-scale experience in a niche business that may directly employ only a few dozen people worldwide yet which can be obscenely profitable if they get it right.  Given that some of these niche businesses have big returns to scale (roughly, that the biggest player makes the most money by a country mile), all this makes the perfect recipe for high pay and bonuses.  That is, at root, why the banks are so insistent that they MUST pay whopping sums and why, even in state-owned banks, the politicians back off when this is explained to them.

These traders and analysts report to managers who may have little or no direct experience of that niche and whose motivations are deeply conflicted by sharing in the bonuses – a principle that applies all the way up the line to the board.   Hence, the FSA is utterley deluded if it thinks that traders’ activities have no bearing on the risks the bank takes or that they can be reliably controlled by their managers per the BBC item referenced above.  Traders specialise in evading and bending rules.  Have they never heard of Nick Leeson or the many other “rogue” traders who lost their employers millions, even billions?

In short, this is a business model built around creating then exploiting market imperfections.   Whereas a regular and socially useful business makes money by serving the needs of its customers, banking has an inbuilt tendency to go beyond this and make even more money by ripping off its customers.  When it does this it becomes a zero sum game, redistributing wealth rather than creating it; knowing that if the house of cards collapses the miscreants will be long gone with their bonuses.

As Akerlof and Romer put it (quoted in “Econned”),

“… an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success).  Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.  Bankruptcy for profit occurs most commonly when a government guarantees a firm’s debt obligations …

“Because net worth is typically a small fraction of total assets for the insured institutions [i.e. they have big assets, but equally big debts]…   bankruptcy for profit can easily become a more attractive strategy for the owners than maximising the true economic value.  If so, the normal economics of maximising economic value is replaced by the topsy-turvy economics of maximising extractable value which tend to drive the firm’s economic net worth deeply negative.” [i.e. leaving a big bill for the taxpayer to pick up] [Emphasis added]

In other words, bank profits are not the result of a healthy economy as they would have us believe.  Rather banking has become an extractive industry hoovering up wealth from the real economy for private gain and its huge profits are symptoms of a sick economy that is succeeding only at the wrong things.

Osborne to give massive tax break to the banks

The big banks are apparently “livid” with Osborne about the additional bank levy he announced this morning; the ensuing row has dominated the headlines.   But, hidden by the row, he is reported to be planning changes to obscure parts of the tax code that amount to a massive subsidy for the banks. 

George Monbiot describes how it works in Comment is free.

At the moment tax law ensures that companies based here, with branches in other countries, don’t get taxed twice on the same money. They have to pay only the difference between our rate and that of the other country. If, for example, Dirty Oil plc pays 10% corporation tax on its profits in Oblivia, then shifts the money over here, it should pay a further 18% in the UK, to match our rate of 28%. But under the new proposals, companies will pay nothing at all in this country on money made by their foreign branches.


 While big business will be exempt from tax on its foreign branch earnings, it will, amazingly, still be able to claim the expense of funding its foreign branches against tax it pays in the UK. No other country does this.

If this is passed, it will mean that paying UK tax is entirely optional for multinationals – all they will have to do to avoid it perfectly legally is to relocate operations to low tax locations overseas with all that implies for investment and jobs.  Any company that doesn’t do so will suffer competitive disadvantage and loose out.   Industrial firms will take some time to restructure but banks, given the ‘weightless’ nature of their products, will be able to move very quickly.  Presumably the bonuses arising from their deals would also be ‘earned’ in tax havens making a mockery of the government’s attempts to rein in the banks.

In short, Osborne is enabling regulatory arbitrage – creating the opportunity for big business (and it is only multinationals) legally to evade any sort of control or tax by ducking and diving round the regulations.  This is no more or less than a latter-day version of buccaneering – the state-licenced piracy of an earlier age.  He probably imagines this will somehow advantage the UK, but how long will it be before the US follows suit negating any benefit.

It makes sense if (and only if) you believe that giving big business whatever it wants is the way to go, that doing so creates wealth and that wealth, once created, will trickle down to ordinary people – conclusions derived from the neoclassical school of economics.  It is what used to be called Thatcherism, is sometimes called neo-liberalism and is what I originally became an activist to oppose.   Way back then (Thatcher was still PM), my opposition was based on instinct that this was somehow wrong even though I couldn’t explain exactly how. 

I see multinationals as being like toddlers in that they don’t have the internalized discipline that comes with maturity.  As with toddlers, self is everything and the competitive pressures on them soon lead to anti-social behaviour unless the state steps in to contain and channel those competitive pressures into socially useful directions.

If the last three decades have taught us anything, it is surely that my instinct was right; Thatcherism has led to a dystopia rather than utopia and doubling up on it is only going to lead to more inequality and more social collapse although some – a tiny minority – will do spectacularly well.

Florida’s Attorney General documents bank fraud

Fraud – blatant and wholesale fraud – on the part of some of the world’s biggest banks has clearly been a major cause of the global financial crisis.  Unfortunately, banking is so opaque and so difficult to understand that bad practice, even criminal practice, is invisible to the average citizen.

Now however, the (Republican) Attorney General of Florida has produced a slide presentation which details with admirable clarity some of what;s been going on in Florida (and in the rest of the USA).   This is a must read even if (perhaps especially if) you do not see yourself as particularly financially literate. 

There is no text to go with the slides but the message is pretty clear nevertheless.  It starts with a brief history of mortgages in America then goes on to explain how they are bundled up and securitized – a complex process that involves assigning them from one owner to another through several hands until they finish up in a ‘trust’, bits of which can be sold off to investors in bite-sized pieces.  (Re slide #7 and following it is helpful to know that in the USA a mortgage consists of two parts, a ‘note’ which is the IOU for the money advanced and the ‘mortgage’ that is the legal document securing the ‘note’ on the property.)

As the presentation wryly observes (illustrating the point with one of Escher’s wonderfully impossible staircase prints), “If the mortgage is not properly assigned …  the result is chaos.”

And, by and large, mortgages were not properly assigned.  The redoubtable Linda Green for instance “signed” hundred of thousands of assignments using multiple signatures while serving as an officer of dozens of banks and mortgage companies.  And in each and every case she was signing that she had personal knowledge of the facts of the case.

At times it descends almost into farce.  One assignment is to “Bogus assignee for intervening asmts” whose address is given as “XXXXXXXXXXXXX”.  In other cases the assignors are, like Indymac and Lehman, defunct but still magically managing to work from beyond the grave, mortgages that were fully paid off have nevertheless been assigned and documents were notarised under authorities that did not exist.

 Naturally, the banks are desperately trying to spin this as just a little paperwork difficulty… nothing to see here… please move on.   Not so.  It is unambiguously criminal.  Playing fast and loose (not to mention using forged and backdated documents which is the clear implication of the abuses strikes at the very heart of a property-owning democracy and indeed there have been cases where homeowners have been foreclosed on who never had a mortgage in the first place.  Also, although not covered in the Florida AG’s presentation, the whole of contract law is meaningless if it is permissible to retrospectively ‘create’ documents to support a desired outcome.

Fortunately, things aren’t so bad in the UK but there is no room for complacency.   Some of our big banks have undoubtedly been very foolish but how far did they go into dodgier territory?  My guess is quite a long way in some cases but we won’t know as long as the toothless and compromised FSA seeks mainly to cover up its own incompetence.

I am reminded that the Pecora Commission which did so much to expose banking malfeasance in the 1930s provided a powerful wave of support for FDR and the eventual implementation of the New Deal.  We should take note.

(H/T Firedoglake)